What is the Federal Gift Tax? The Rules for 2012 (And Beyond?)

February 24, 2012

Let’s discuss federal gift taxation for 2012.

Our government has been fairly active lately initiating proposals for gift taxes in 2013 and beyond. For example, earlier this month, President Obama proposed the application of the gift tax rules that were in place in 2009. Since this would result in a higher gift tax rate (up from 35% to 45%) and a lower lifetime exemption (down from $5.12 million to $1 million), it is probably worth taking a few minutes to further understand exactly what is involved.

Common recommended estate planning strategies, such as gifting as much as possible while you can before 2013, are beyond the scope of this post. Instead, we’ll cover the main rules in effect now and also apply them to two somewhat common scenarios.

Gift Tax Rules

These rules apply to “inter-vivos” gifts (i.e. made during a person’s lifetime) only, whereas estate taxes apply to gifts made after death.

  • The federal gift tax is imposed on property transferred by gift by U.S. residents or non-residents. 26 U.S.C. § 2501(a).
  • The tax is paid by the gift’s donor. 26 U.S.C. § 2502(c).
  • The tax is applied in each year the donor gives away property.
  • Calculation – The gift tax is equal to the gift tax rate multiplied by the amount of “taxable gifts” made during the calendar year. 26 U.S.C. § 2503(a).
    • In 2012, the maximum gift tax rate is 35%.
  • To calculate “taxable gifts”, take the total amount a donor has given in a calendar year and reduce it by the following:
    • Exclusions
    • Lifetime Exemption
    • Deductions

Exclusions

Several items are excluded from the definition of “gift”, which results in most citizens or residents never having to pay the gift tax:

  • Annual Exclusion
    • In 2012, the first $13,000 of gifts to any individual are not subject to gift taxes. See 26 U.S.C. § 2503(b).
  • Qualified Transfers for Educational or Medical Expenses
    • Qualified Transfers are also excluded from the calculation.
    • A qualified transfer is any amount paid on behalf of another individual (the “donee”):
      • As tuition to an educational organization for the donee’s education or training.
      • To a person who is directly paid to provide the donee with medical care. 26 U.S.C. § 2503(e).

Lifetime Exemption

Additionally, all U.S. citizens and residents are permitted a lifetime gift tax credit.

  • In 2012, the first $5.12 million of lifetime gifts above and beyond the exclusions stated previously are exempt from gift taxes. 26 U.S.C. § 2505(a).

An individual’s lifetime credit is reduced each time he or she makes a taxable gift. Depending on the size of the donor’s gift(s), the credit can be used up in one calendar year or in multiple years. See Example 2 below.

Deductions

Finally, the following may be deducted from the donor’s total gifts:

  • Gifts to Charity26 U.S.C. § 2522 details the differing rules for U.S. citizens, residents, and non-residents. .
  • Unlimited Marital Deduction – In general, any gift to one’s spouse is fully deductible for gift tax purposes. 26 U.S.C. § 2523 explains when and how this rule applies, and includes the rules for gifts of life estates, joint interests, and charitable remainder trusts, as well as the limits where the donor’s spouse is not a U.S. citizen.

Examples

To hopefully illuminate all of that, here are two examples that further explain the concepts:

  • Example 1 – A married couple has 3 children, and pay the following in 2012:
    • They buy presents for each child for their birthdays and holidays. The total values of the gifts to each child do not exceed $26,000.
    • They cover all of their children’s medical expenses by paying the doctor directly at the time of each visit.
    • They pay college tuition directly to their first child’s university.
    • They pay private school tuition for their other 2 kids directly to the school.
    • The wife directly transfers $500,000 of mutual fund assets to the husband’s account to equalize the amounts in their estates.
    • Result– No gift tax is owed.
      • The couple’s $13,000 annual exclusions can be combined if joint gifts are made.
      • They make qualified payments to doctors and schools.
      • The wife’s gift qualifies for the unlimited marital deduction.
  • Example 2 – A widower, W, has a $9 million estate and decides to live more simply. He wishes to immediately give $1.5 million gifts to each of his 4 children. He previously reported a $1 million gift to his brother in 2005 but paid no gift tax at that time.
    • Result – W would owe approximately $616,750 of gift taxes in 2012, calculated as follows:
      • Annual exemption – The $13,000 annual exemption would apply to each child’s gift, so $1.487 million of each child’s gift would be subject to gift tax.
        • The four gifts would total $6 million, $5.948 million of which is taxable, and must be reported to the IRS.
      • Prior Gift
        • In 2005, the annual exemption was $11,000. Therefore, $989,000 of W’s gift was subject to gift tax that year.
        • This amount is deducted from W’s lifetime exemption amount of $5.12 million.
      • Therefore, entering 2012, W had $4.131 million of his lifetime exemption remaining.
      • W’s $5.948 million in 2012 gifts less $4.131 million of his lifetime exemption equals $1.817 million of taxable gifts.  Using the 2011 gift tax tables for this $1.817 million results in the $616,750 gift tax stated above.
      • NOTE:  A big thank you to Zachariah White from The Math Forum @ Drexel University for correcting my calculations.

Of course, real life is usually much more complex. However, in addition to applying the rules stated above, these examples hopefully illustrate that while most will not owe any gift taxes in 2012, a greatly lowered lifetime exemption in 2013 and beyond could necessitate some changes in your plans.

Questions or Comments

Please comment below. Thanks for stopping by!

 What is the Federal Gift Tax?  The Rules for 2012 (And Beyond?)
 What is the Federal Gift Tax?  The Rules for 2012 (And Beyond?)

Scott

Scott R. Zucker, Esq. is the owner of The Zucker Law Firm PLLC, located just outside the Capital Beltway in Annandale, within five miles of the City of Fairfax, the county seat of beautiful Fairfax County, Virginia. The firm focuses mainly on estate planning services for Virginia, Maryland and Pennsylvania clientele, and seeks to do so in an affordable and approachable way. People interested in learning more can contact Scott by phone or email.

More Posts - Twitter

Tags: , , , , , , , , ,

36 Responses to What is the Federal Gift Tax? The Rules for 2012 (And Beyond?)

  1. Max
    March 12, 2012 at 1:53 am

    Great update on the Federal Gift Tax rules. The examples are definitely helpful in tax planning.

    • Scott
      March 15, 2012 at 5:28 pm

      Max–

      Thank you so much! Thanks for stopping by as well!

      Take care,
      Scott

  2. steven levine
    July 3, 2012 at 3:47 pm

    what will the annual gift tax exemption be in 2013?

    • Scott
      July 3, 2012 at 11:26 pm

      Mr. Levine–

      At this point we don’t know yet. The annual exclusion is calculated by multiplying $10,000 by a cost-of-living adjustment since 1997 based on the U.S. Department of Labor’s Consumer Price Index. See 26 U.S.C. 2503(b) for further detail.

      The current exclusion, $13,000, will remain until the above formula produces a result that either exceeds $14,000 or, in the unlikely case of deflation, falls below $13,000.

      I hope this helps. Thanks for stopping by!

      Take care,
      Scott

  3. Patgrazer
    July 15, 2012 at 2:08 pm

    Is an irrevocable trust for real property made to my three sons within three years. Of my death included in my gross estate? Islit deducted from my lifetime exemption?

    • Scott
      July 17, 2012 at 4:00 pm

      This is covered in 26 U.S.C. Section 2035(a).

      If you make a transfer (by trust or otherwise) of an interest in any property during the 3-year period ending on the date of your death, and it would have been included in your gross estate, that property would be included in your gross estate. This would include your individually-owned real property transferred into an irrevocable trust within 3 years of death because such property would have been included in your gross estate. See that section of the Code for further details.

      Any amount gifted that exceeds the annual exclusion would indeed be deducted from your lifetime exemption.

      I hope this is helpful.

      Take care,
      Scott

  4. Dat nguyen
    August 3, 2012 at 7:46 pm

    Our apartment buildings market values are $10M. There are $4M loan total on them. My wife and I want to gift all to my 3 children. Could you please tell me total of gift should be considered $8M (10M-4m=6M total equity amounts) or $10M (total of apartment market values)?

    • Scott
      August 30, 2012 at 4:32 pm

      Mr. Nguyen–

      In broad terms, I’m assuming that you would want the gift to equal the equity amount rather than the total market values (as you obviously wouldn’t want to a) be paying down the loan while your children owned the property outright and b) potentially pay millions more in gift or estate taxes later on).

      For your specific case, I would recommend that you contact an estate planning and/or real estate attorney to structure the deal. There are various techniques you could use to reduce or eliminate your gift or estate tax liability, but these would depend on the actual values of your properties, the amounts of the loans, your state law, etc. In any event, combining estate, property and tax law and getting a proper valuation of the property with your children’s ability to take on the mortgage and figuring out the best strategy for your situation is a very complex process that you probably shouldn’t take on yourself.

      Best wishes, and good luck!

      Take care,
      Scott

  5. Anonymous
    August 27, 2012 at 6:12 pm

    Does the donor of a gift after the 13,000 per year pay tax on the amount over? or can they fill out fill out the 709 form? or does that apply to the receiver?
    Thank you for your reply…

    • Scott
      August 30, 2012 at 4:20 pm

      Anon–

      A donor giving over the annual exclusion amount to any individual in any year is required to fill out the Form 709 for that year. Any excess gift amount is subtracted from the donor’s lifetime exemption (currently $5.12 million).

      Example: A donor gives his child $100,000 outright in 2012. He must report the gift on the 2012 Form 709. Since the gift exceeds the annual exclusion amount by $87,000 ($100,000 minus $13,000), his lifetime exemption would be reduced to $5.033 million ($5.12 million minus $87,000).

      I hope this helps.

      Thanks for stopping by!

      Take care,
      Scott

  6. Marty
    August 29, 2012 at 9:20 am

    Scott, GREAT information here!

    Question: If parents gave $40,000 to a son and his wife, should their be a gift tax return filed? or are they exempt?

    Thanks
    Marty

    • Scott
      August 30, 2012 at 4:11 pm

      Marty–

      Thank you for your kind words!

      Parents can currently give a total of up to $26,000 to any individual (if both parents approve of the gift). Therefore, parents can give up to $52,000 to a son and his wife without having to file a gift tax return. Therefore, the parents in your situation would not have to file.

      Thanks for stopping by!

      Take care,
      Scott

  7. Ed
    September 10, 2012 at 12:59 pm

    Thank you for the information. If we are looking to move money from a single parent to her daughter’s family, can she gift $13,000 to her daughter, $13,000 to her son-in-law, then $13,000 to each grandchild? If they set up a family trust does that change things?

    • Scott
      September 16, 2012 at 5:53 pm

      Hi Ed–

      In 2012, an individual can give $13,000 to any individual. Therefore, the single parent can indeed gift $13,000 to her daughter, another $13,000 to her son-in-law, another $13,000 to grandchild #1, another $13,000 to grandchild #2, etc.

      Setting up a revocable family trust will not change things because federal law does not treat such trusts as a separate entity from the original grantor (in your case, the single parent). There may be other gifting techniques available to the single parent, but this would require further analysis regarding her finances and her wishes.

      I hope this helps. Thanks for stopping by!

      Take care,
      Scott

  8. RK
    September 11, 2012 at 10:25 pm

    My wife and I want to gift to our two children a commercial complex worth approx 4 million, no mortgage, and 100% fully leased. We would of course want to continue to receive a “draw” sufficient to provide for ourselves.
    What are the tax implications for our two children and my wife and I.

    • Scott
      September 16, 2012 at 7:02 pm

      RK–

      This is not a simple question because there are one of several techniques you could use to accomplish your goals. Probably the most effective ones, such as using a Family Limited Partnership or Limited Liability Company, involve “leveraging” you and your wife’s lifetime gift tax exemptions ($5.12 million through 2012).

      Let’s do some basic back-of-the-envelope calculations (all values are approximated and are merely intended to show you the overall concept).

      For example, say both you and your wife gift the commercial complex outright to your children. If you and your wife currently own it 50-50, then the value of your gifts would be $2 million each. If you each still had your full $5.12 million lifetime gift exemption, this gift would reduce each of your available lifetime exemptions down to $3.12 million (5.12M less 2M).

      Instead, let’s say you transferred the complex into a Family Limited Partnership, and because of the ownership structure you chose, the IRS allows you to value this gift at a 30% discount. Your gift could then be “leveraged” for gift tax purposes — i.e. when calculating gift taxes, this gift would be valued at 70% of $4 million, or $2.8 million ($1.4 million each for you and your wife).

      As a result, both your available lifetime exemptions would reduce to $3.72 million ($5.12M less $1.4M) and potentially save both of your estates over $400,000 in gift taxes.
      Other available structures can similarly leverage your gift (i.e. treat your $4 million transfer as a discounted, lesser-valued gift).

      Of course, you could also owe income taxes annually depending on how you receive the draw.

      Please note that you should really make sure you work with professionals, mainly so that you don’t lose the benefits you are intending based on mistaken wording in your documents.

      Thanks for stopping by! I hope this helps.

      Take care,
      Scott

  9. BILL SALSBUURY
    September 16, 2012 at 11:28 am

    Scott: A excellent read,it helps me better share with the President and Vice President of the Company that I serve as their CFO.

    • Scott
      September 16, 2012 at 7:03 pm

      Thank you, Bill!

  10. October 7, 2012 at 7:10 pm

    If someone gives another person (not related) amillion dollars is there a tax to pay and by which party?

    • Scott
      November 6, 2012 at 11:14 pm

      Steve–

      Thanks for writing!

      Assuming that the gifting person has never given a large gift before and the gift is in cash, there would be no immediate tax to pay. However, the person’s lifetime estate and gift tax exemption would reduce by $987,000 (the $1 million gift less the $13,000 annual exclusion). The recipient would not owe any gift tax for this gift.

      However, all of this will depend on how much your gifting person has already given during his or her lifetime and how Congress resolves the lifetime exemption question for 2013 and beyond.

      Additionally, transfer or capital gains taxes may be owed. For example, if the gifting person is instead giving a gift of property (such as a stock or real estate) that has increased in value during the time the gifting person owned it, then the recipient may owe capital gains taxes once he or she sells the property.

      I hope this helps.

      Take care,
      Scott

    • Scott
      November 20, 2012 at 6:43 pm

      Steve–

      According to current federal law, a $1 million gift by itself does not subject the donor or the donee to any gift tax. Instead, the donor’s lifetime exemption is reduced by the amount of the gift less the annual exclusion (currently $13,000). Therefore, in your case, the donor’s lifetime gift tax exemption would be reduced by $987,000.

      This is not to say that no tax would be owed. For instance, if the donor has previously given out the full amount of his lifetime gift tax exemption, then he would owe gift tax in the year the gift was given. For example, let’s say Jack gave his friend Jill $1 million in 2012, and had already given out $5.12 million in gifts in prior years. Jack would then owe the IRS $326,250 (gift tax for $987,000) for his 2012 gift.

      Additionally, if the donor gave the donee property that had increased in value since the donor purchased it, the donee would take on the donor’s tax basis. The donee would then owe capital gains taxes on the overall gain in the year he/she sold the property.

      A long answer to a short question, I know. I hope this is helpful.

      Take care,
      Scott

  11. Lorene
    October 9, 2012 at 8:53 am

    Mother has $265,000 invested that she wants to turn over (give) to my brother and me. This is the total amount of what she has so there will be no other disbursements in the future. Is there a gift tax due next year? Or is there no tax because she is giving less than the $5,000,000? So confused.

    • Scott
      November 20, 2012 at 6:28 pm

      Lorene–

      If Mother has not given any other gifts that exceeded the annual exclusion (currently $13,000 per year) during her lifetime, then no gift tax would be owed on this gift. Since she is permitted to give you and your brother $13,000 each without any gift tax consequences, $239,000 of her gift ($265,000 less $26,000) would need to be reported to the IRS.

      Upon her death, this $239,000 amount would be subtracted from her lifetime estate and gift tax exemption ($5.12 million for 2012, unknown for 2013 and beyond). If she passed away in 2012 after giving you the gift and she had no other assets, her lifetime exemption would be reduced to $4.881 million ($5.12 million less $239,000). In other words, only the amount of her estate that exceeded $4,881,000 would be subject to federal estate tax.

      Let me know if you have any follow up questions.

      Take care,
      Scott

  12. David Davidson
    October 19, 2012 at 3:19 pm

    Scott
    Your explanation of the rules are so simple and clear. I wish the IRS will ask you to re-write their publications.
    Regarding the gift of appreciated real estate, who pays the tax on gain? And when? If to be paid by donee later, what will be his base?
    I ask this question with the “step up at death” in mind.
    Thank you

    • Scott
      November 20, 2012 at 6:19 pm

      David–

      Thank you for your compliments!

      Basically, if you give someone else appreciated real estate during your lifetime, the donee would owe the tax on the gain in the year he/she sold the property.

      For example, say you bought property in 2000 for $100,000 and gave it to someone else in 2012 when it was worth $200,000. The donee would then take on your $100,000 basis. If the donee then immediately sold it, he/she would owe capital gains tax on the $100,000 gain (assuming no other deductions apply) for 2012. If the donee instead sold it in 2013, he/she would owe the capital gains tax for 2013.

      Upon death, an individual’s property receives a step-up (or step-down) in basis to its date of death value. For example, if Ms. A bought property in 2005 for $500,000 and died in 2012 when it was worth $750,000, Ms. A’s beneficiary would be able to use the higher $750,000 value as his/her basis.

      I hope this helps.

      Take care,
      Scott

  13. October 31, 2012 at 9:12 am

    Scott,
    What is the tax implications if we (me as sole earner and my wife an homemaker) can gift to our only son (born abroad) gift 15k.

    In this case, are we permited to do so and 2nd, who pays the tax considering that we file jointly and son has TIN (no SSN).

    Thanks
    Marsall

    • Scott
      November 20, 2012 at 6:07 pm

      Marshall–

      Under U.S. law, any individual may give another individual up to $13,000 in any given year without any gift tax consequences. This means that together, you and your wife can give another individual (including your son) up to $26,000 in any year. Therefore, a gift from both you and your wife to your son for $15,000 would not have any gift tax consequences.

      I hope this helps. Thanks for stopping by.

      Take care,
      Scott

  14. LMJ
    November 7, 2012 at 6:15 pm

    What happens if a $5,000,000 gift is made in 2012 and death occurs in 2013? Is the taxable gift added back to the estate and then the full credit taken? If so what credit, the one for 2012 or what ever in 2013?

    Thanks

    • Scott
      November 20, 2012 at 6:00 pm

      LMJ–

      This is an excellent question, and it is unfortunately one without a definitive answer as of this date. If the lifetime exemption is lowered for 2013 and beyond, some are worried about the “clawback” problem — i.e. taxing for an action that was previously deemed exempt.

      In my humble opinion, I don’t believe that Congress would renege on the promise of the higher exemption, especially after a contentious election. This would mean that if a person made a $5 million gift this year, it would remain non-taxable for his or her lifetime since the donor is acting within the bounds of the current rules.

      However, this result is not guaranteed, so there is at least a tiny risk that there will be a clawback. Depending on your goals, you (or anyone) should certainly consult a lawyer or other professional to figure out your options.

      I hope this helps.

      Take care,
      Scott

  15. ed
    November 26, 2012 at 7:43 pm

    Scott,

    I’ve got to ask the question that has probably crossed many readers’ minds – - – If someone wants to give a large gift (e.g. $100,000 to $500,000) to a friend or relative, what’s to prevent them from just writing a check and giving it to them and not bothering to fill out any gift tax forms? If they really want to avoid a paper trail it seems they could pretty easily just buy gold coins and give those to the recipient to sell as needed to supplement their future income.

    I know my estate won’t exceed the IRS lifetime gift exclusion, but I could certainly understand how someone who worked hard for their whole life would REALLY resent the government feeling it’s entitled to yet another large slice of their earnings – after having already paid income taxes on it when it was earned.

    • Scott
      December 3, 2012 at 6:13 pm

      Ed–

      This is an excellent question, and one that not so many people even think about.

      Unfortunately, the reason that you need to go to the trouble to fill out gift tax forms in your scenario is because the IRS has access to a lot more information than you might think, whether directly or indirect. Here are some examples of how this is so:

      1) There is generally a waiting period for your check to clear if you try to make a large deposit into your bank account.
      2) You must fill out a tax form in the casinos if your winnings exceed a certain amount.
      3) IRS audits will occur if a portion of your return falls outside a certain range. You know that six figure code you write in for your profession? The ranges are derived from the average amounts placed on the returns of the hundreds or thousands using the same codes.
      4) Inevitably, a large gift will begin to produce taxable income, and the IRS will notice a large difference from year to year.
      5) The IRS recently started a practice of looking at local real estate records to help them determine how young families were able to cover a down payment to buy their houses. If their research didn’t jibe with the norm, the IRS then looks closely at their parents’ returns to see if they could reverse engineer an unreported gift.

      In the aggregate, these reasons add up to a system that can more easily identify large gifts than one might think.

      Thanks for stopping by the site.

      Take care,
      Scott

  16. Earle Christianson
    December 10, 2012 at 5:05 pm

    Hey Scott,

    happened upon your blog by chance and very glad that I did. Great stuff.

    Just to make sure that I’m clear though, if a single parent gave each of 4 kids $50,000, with no real substantial gifts prior to that to anyone else, the giver would simply need to fill out the form when filing, correct? No actual taxes would need to be paid if all $200K still kept them under the lifetime amount, correct? It sounds like it is just a filing thing at that point.

    Looking forward to your answer and the needed clarity. Thanks again!

    • Scott
      January 4, 2013 at 4:55 pm

      Earle–

      You are correct — it is just a filing thing at that point.

      Thank you for your kindness and for checking out the site!

      Take care,
      Scott

  17. James
    December 19, 2012 at 4:44 pm

    Hi Scott,

    Excellent info here!

    I have a question on the rules still on the annual exclusion that is $13000 to any person. If person A wants to gift person B a larger amount, say $130,000 within the year without incurring gift taxes, what prevents him from giving 10 middlemen an amount of $13000 first, and having them each gift to person B? Would that be illegal?

    • Scott
      January 4, 2013 at 4:51 pm

      James–

      Thank you for the compliment!

      Before I answer, please be alerted that the annual exclusion has risen to $14,000 to any person for 2013.

      The problem with your scenario is that the exclusion applies to “gifts” only. A gift is usually defined as having no strings attached. If A gave $14,000 to B, C, D, etc. with the intention that they all then turn around and give that amount to Z, then the 10 original transactions would probably not be recognized as a pure gift and therefore not qualify for the exclusion.

      I hope this helps. Thanks for stopping by!

      Take care,
      Scott

Leave a Reply

Your email address will not be published.

CommentLuv badge